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Dividend Stocks Shares

Wesfarmers Ltd – Exceptional Growth

Wesfarmers is one of Australia’s largest private-sector employers, with more than 100,000 employees. Wesfarmers has a wide moat, which is sourced from cost advantages derived from its significant retail scale. After the demerger of Coles in 2018, returns on equity are no longer affected by goodwill associated with the 2008 acquisition of Coles and returns on invested capital comfortably exceed the group’s weighted cost of capital.

Key Investment Consideration

  • Leading Australian hardware retailer Bunnings generates about half of the group’s operating income and we expect the chain to continue building its market share. Bunnings is exposed to the health of the Australian housing market and the cyclical weakness in home prices is likely to negatively affect sales and profitability.
  • Wesfarmers offers investors an opportunity to diversify across different categories in the discretionary retail sector, beyond hardware, with additional diversification provided by its smaller industrials division.
  • Wesfarmers is Australia’s best-known conglomerate. Activities span discount department stores, office supplies, home improvement, energy manufacture and distribution, industrial and safety supplies, chemicals, and fertilisers. Business interests can be divided into two broad groups: retail and industrial.
  • The company’s hardware store footprint across the Australian economy and its leading market positions within several segments, combined with strong underlying return on invested capital (before goodwill), lead to our wide moat rating.
  • Wesfarmers is one of Australia’s largest retailers, and despite the Coles demerger, still earns around 80% of sales from the retail channel across discount department stores, hardware/home improvement, and office supplies.
  • The Bunnings is the undisputed leader in Australian home improvement retailing. Based on its market position, Bunnings could start giving up some volume growth and improve profitability by increasing prices. OThe diversification of Wesfarmers’ revenue streams across multiple retail categories and industrial businesses lowers earnings volatility and better predictability of dividends for income investors.
  • Wesfarmers’ strong balance sheet lowers funding costs, but also provides the financial firepower to opportunistically pursue acquisitions.
  • Wesfarmers’ retailing businesses are pro-cyclical and the near-term outlook for the Australian economy and consumer spending is mixed at best.
  • Mergers and acquisitions are risky and can be value destructive to shareholders. Wesfarmers’ most recent acquisition, Homebase in the U.K. and Kidman Resources were ill-timed and cost investors dearly.
  • The department store segment is grappling with intense competition from online, international apparel retailers and most importantly Amazon Australia, but are also confronted with the secular decline of thedepartment store format.

 (Source: Morningstar)

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks Shares

Westpac Banking Corp– Earnings To Retrace

Margins are currently being compressed as cash rates fall to historically low levels and demand for credit growth remains weak. Starved of revenue growth opportunities, the bank will focus on cost-cutting initiatives. A significant penalty for breaching anti-money-laundering laws has been agreed hurts 2020 earnings, as will higher loan impairment expenses over the next few years. During tough economic conditions, capital strength is paramount, with the dividend payout ratio expected to remain between 50% and 70%.

Key Investment Considerations

  • Market concerns about housing and weaker economic conditions are exaggerated. After a period of exponential growth Australian house prices cooled in 2017 and 2018, but a collapse remains unlikely without a sustained spike in unemployment.
  • Cost-saving initiatives are needed to further improve operational efficiency and increase returns.
  • Common equity Tier 1 capital exceeds regulatory requirements but changes to capital requirements in New Zealand, regulatory penalties, rising credit stress, and additional customer remediation costs have the potential to reduce this comfortable position.
  • Improving economic conditions underpin profit growth from fiscal 2021. Productivity improvements are likely from fiscal 2022.
  • Cost and capital advantages over regional banks and neo-banks provide a strong platform to drive credit growth.
  • Consumer banking provides earnings diversity to complement the more volatile returns generated from business and wholesale banking activities.
  • The withdrawal of personal financial advice by Westpac salaried financial advisors reduces compliance and regulatory risk.
  • Slow core earnings growth has resurfaced because of low loan growth, margin compression, subdued wealth and markets income, lower banking fee income.
  • A sound capital position will be tested by inflation in risk weighted assets.
  • Increasing pressure on stressed global credit markets could increase wholesale funding costs.
  • Bad debts remain under control, but large provisions are being taken in anticipation that COVID-19 will have a large negative impact on many businesses and households.

 (Source: Morningstar)

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Commodities Trading Ideas & Charts

Woodside Petroleum – Ideally Placed

Under its watch, the number of LNG trains has grown from one to five, taking gross output to 16.4 million metric tons per year. This pedigree is unmatched in the Australian oil and gas space, and there’s more potential development in the pipeline if prices will allow. Missteps, including commissioning delays and cost blowouts during the China-driven resources boom, are now past. Woodside has demonstrated commendable conservatism in capital allocation over several years.

Key Investment Considerations

  • More than 80% of our Woodside fair value estimate derives from one product, LNG. LNG prices are referenced on a three-month running lag to the Japanese Customer Cleared oil price, so oil prices are key to any analysis.
  • Including Pluto Train 2 and Other Prospects, around 30% of our fair value estimate derives from projects yet to produce any gas, reflecting our expectation for substantial growth.
  • We are comfortable with a high proportion of value in development projects, given Woodside’s proven LNG delivery platform and first-mover advantage on the North West Australian coast.
  • As Australia’s premier oil player, Woodside Petroleum’s operations encompass liquid natural gas, natural gas, condensate and crude oil. However, LNG interests in the North West Shelf Joint Venture, or NWS/JV, and Pluto offshore Western Australia are the mainstay, and the low-cost advantage of these assets form the foundation for Woodside. Future LNG development, particularly relating to the Pluto project, encompasses a large percentage of this company’s intrinsic value.
  • Woodside is well suited to the development challenge. With extensive experience, it remains a stand-out energy investment at the right price. Gas is the fastest growing primary energy market behind coal, and the seaborne-traded LNG portion of that gas market grows faster still. China is building several import terminals, and so demand is likely to pick up, helping to move LNG pricing toward oil parity on an energy-equivalent basis.
  • Woodside is a beneficiary of continued global economic growth and increased demand for energy. Behind coal, gas has been the fastest-growing primary energy segment globally. The traded gas segment is faster-growing still, and Woodside is favourably located on Asia’s doorstep.
  • Woodside’s cash flow base is comparatively diversified, with LNG production making it less susceptible to the vagaries of pure oil producers. Gas is a primary component of Asian base-load power generation, instilling an element of demand stability, and is generally sold under long-term contracts.
  • Gas has around half the carbon intensity of coal, and it stands to gain market share in the generation segment and elsewhere if carbon taxes are instituted, as some predict.
  • The global economy is cooling off and demand for energy will follow suit, particularly if Chinese growth rates taper.
  • Technological advances in the nonconventional U.S. shale gas industry have the potential to swing the demand supply balance increasingly in favour of the customer.
  • LNG developments are hugely expensive, and the balance sheet is at risk until such projects are successfully commissioned.

(Source: Morningstar)

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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IPO Watch

IPO Maximises Pexa’s Value but Link Fair Value Estimate Maintained

However, it appears Pexa will achieve an initial public offering, or IPO, enterprise value of AUD 3.3 billion, which is considerably higher than our prior AUD 2.20 billion valuation as of October 2020, and KKR’s now withdrawn AUD 3.10 billion enterprise value-based offer, made last week. It’s also 70% above the implied AUD 1.95 billion offered by the PEP/Carlyle Group Consortium in October 2020. Link’s board and executives have played their Pexa cards shrewdly to maximise value for Link shareholders which has significantly reduced the gap between Link’s share price and its fair value. All else equal, we’re indifferent as to whether this happens by selling the Pexa stake or via retaining the shareholding in a listed company. However, at the current market price of around AUD 5.20 per share, we still believe Link is materially undervalued.

We estimate Pexa has around AUD 150 million in cash, implying an equity value of AUD 1.52 billion for Link’s 44% shareholding at the IPO valuation. Media reports indicate Pexa will borrow AUD 300 million before its IPO and that most of Pexa’s cash will be returned to its existing shareholders. This implies around AUD 200 million in cash that will be attributable to Link, however, Link’s announcement indicates around AUD 150 million of this cash is likely to be reinvested into Pexa at the IPO to increase its shareholding to 47%. We expect the Pexa shares made available via the IPO will mainly come from the full sell-down of Morgan Stanley’s 40% shareholding in the company, with both Link and the Commonwealth Bank of Australia likely to increase their shareholdings.

The AUD 1.52 billion valuation of Link’s Pexa stake is a far better outcome than the AUD 1.14 billion we estimated Link would receive via a trade sale to KKR. However, unlike the KKR valuation, our IPO-based valuation excludes any deduction for capital gains tax. Quantifying the tax owed on the Pexa investment by Link is complicated under the IPO scenario because we expect Link will ultimately distribute its Pexa shareholding to Link shareholders via an in-specie distribution. We expect this option will enable retail shareholders to claim the 50% capital gains discount on their Pexa shares. However, we await the tax ruling on the Pexa shareholding and recommend Link shareholders seek independent taxation advice on this issue.

All else equal, Pexa’s AUD 3.3 billion enterprise value could increase our Link fair value by AUD 1.00 per share to AUD 7.90. However, due to the uncertainty regarding the details of the IPO, and particularly the tax implications for Link shareholders, we have maintained our fair value pending the release of additional information from both Link and Pexa. We also intend to reassess our Pexa valuation based on the IPO prospectus and management roadshow, and particularly the potential earnings upside from exploiting its data and overseas expansion.

We are also yet to determine the extent to which Pexa’s market value is incorporated into Link’s carrying value of the Pexa stake.

Link Administration Holdings Ltd Company Profile

Link provides administration services to the financial services sector in Australia and the U.K., predominantly in the share registry and investment fund sectors. The company is the largest provider of superannuation administration services and the second-largest provider of share registry services in Australia. Link acquired U.K.-based Capita Asset Services in 2017; this provides a range of administration services to financial services firms and comprises around 40% of group revenue. Link’s clients are usually contracted for between two and five years but are relatively sticky, which results in a high proportion of recurring revenue. The business model’s capital-light nature means cash conversion is relatively strong.

Source: Morningstar

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks

Strong Cycling Demand Amid Pandemic Drives Record Sales for Shimano in First Quarter of 2021

Shimano has capitalized from a significant rise in demand for bicycles since the second half of last year, as its bicycle component business (which makes up about 80% of revenue) boasts the leading global share of medium/high-end gears. The rise in demand is attributed to more people partaking in cycling as a mode of transportation and as an outdoor activity that allows people to avoid close-contact in crowded spaces amid the pandemic. We expect sales to remain at similar, high levels for the second quarter, as retailers in Europe and North America (Shimano’s largest markets) as well as bicycle frame manufacturers look to restock their inventory to keep up with demand.

We currently assume record sales with a 17% year-on-year growth in fiscal 2021, but we continue to pay attention to: 1) any potential signs of whether some of the momentum starts to slow down in the second half compared with recent peak levels, as increased vaccinations might lead to other interests than activities that promote social distancing; and 2) further improvement in supply chain-related issues to keep up with high demand levels. The company has been able to improve capacity utilization to better meet increasing demand, compared with last year, by eliminating many of the bottlenecks related to production. Further, with construction of a new factory in Singapore, we expect this will increase total production capacity by about 10% next year. While fixed costs related to the construction will likely impact margins in the near term, we still think Shimano will realize operating margin expansion in 2021, to an all-time high of 23% from 21.9% in 2020.

Shimano also witnessed a record top-line growth rate of 64% year on year, in the first quarter. Aside from strong retail sales of bicycles and related products in Europe and North America in the first quarter of this year, the comparable period a year ago was weak due to demand initially plummeting as lockdown measures meant many people stayed at home. Fishing tackle sales, which essentially makes up about the remaining 20% of companywide sales, also increased by 26% year on year in the first quarter from a warm winter in Japan as well as strong demand across its key overseas markets. As a result of increasing divisional sales across all business segments and improved capacity utilization, operating margin for the quarter also reached its quarterly peak at 25.8%, up from 16.5% in the same quarter previous year.

We note orders for its new high-end EP8 sport e-bike components series were favorable this quarter, implying an improvement from the previous year in fiscal 2020 when capacity constraints led to year-on-year declines in product sales. Further, and more importantly, this reaffirms our view that the company is able to adapt to evolving trends to remain competitive in newer areas within the cycling industry. According to management, e-bike components currently make up about 10% of Shimano’s total bicycle segment’s divisional sales and is expecting related sales to increase to record levels at about 40% higher than in 2019. As demand for its new high-end products, like the EP8 as well as the Deore MTB components, continue to grow, we expect favorable product mix will also contribute to improved margins in 2021.

Shimano Inc Company Profile

Shimano develops, manufactures, and distributes bicycle components, fishing tackle, and rowing equipment. The company also develops and distributes lifestyle gear products, such as apparel items, shoes, bags, and related items. Approximately 80% of companywide operating income comes from its bicycle components segment. It has operations in Japan, Asia, Europe, North America, Latin America, and Oceania. The company was founded in 1921 and its headquartered are in Osaka, Japan.

Source: Morningstar

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Shares Technology Stocks

Airbus Build Rate Announcement Prompts Us to Slightly Bump Up Our GE Fair Value Estimate

Stock exchange market concept, stock broker looking at graph working and analyzing with display screen, pointing on the data presented and deal on a exchange, Businessman trading stocks online.

First, GE has materially reduced its debt burden by $30 billion during Culp’s tenure. While some portfolio decisions like the sale of biopharma were painful, they were well-priced and provide the firm with critical flexibility to shift from a persistent defensive to offensive posture. While GE industrial net debt/EBITDA remains high, we think that the eventual aerospace recovery and continuous improvement initiatives will help drive this figure below 2.5 times by 2023. The gradual sale of Baker Hughes furthers GE deleveraging goals, while allowing the firm to focus on its core portfolio.

Second, we believe narrow-body commercial revenue should recover at a more accelerated pace relative to wide-bodies given favorable domestic over international travel trends. We also expect highly profitable narrow-body aftermarket services will recover ahead of the rest of the commercial aerospace portfolio since this business is driven by departures as opposed to revenue passenger miles. Deferring shop visits can add 20%-30% to airlines’ costs, and passenger survey data persistently reveals a majority of passengers are willing to travel once vaccinated. From this standpoint, GE is well-positioned to capitalize on this trend, with more narrow-bodies that are 10 years or younger than the rest of the industry, and roughly 62% of its fleet seeing one shop visit or less. At a minimum, we believe GE has an opportunity to enjoy strong incremental margins on a recovery matching decremental margins during the recession.

Finally, healthcare is a global leader in precision health, with technology helping practitioners gain valuable insights and eliminating waste in the healthcare system. We expect 50-basis points of consistent margin improvement on lower mid-single-digit growth.

Fair Values and Profit Maximisers

After reviewing Airbus’ announcement that it’s increasing production rates for the A320 family to 64 per month by the second quarter of 2023, we raise our GE fair value estimate to $15.70 from $15.30. Airbus may ask suppliers to enable production rates to as high as 75 per month by 2025. However, we would like to see Airbus build a bigger backlog before increasing our forecast to these levels. Even so, we think this supports our view that the back half of 2021 should witness a rosier commercial aero outlook based on the domestic travel data we previously highlighted.

Even with an estimated $3.7 billion headwind from the end of most of GE’s factoring program, we’re expecting just over $4.6 billion of industrial free cash flow. We also model adjusted EPS of $0.28 for 2021, just over the top end of management’s guide. Nonetheless, we still value GE at over 20 times 2023 adjusted EPS, or about 17.5 times 2023 industrial free cash flow per share. In our view, the two most important contributors to GE’s earning power lie in GE Aviation and GE Healthcare. Aviation will have significant headwinds in the front half of 2021. Nonetheless passenger survey data and airline booking data suggest significant pent-up demand. Longer term, we think global middle income class growth will drive demand once more and help GE commercial aviation recover lost sales by 2024 to year-end 2019 levels. GE’s fleet is young and strongly positioned in narrow bodies, which should help GE as domestic travel recovers ahead of international travel. Further, a majority of its fleet is still yet to see over one shop visit. Airlines deferring maintenance, moreover, can add considerable costs to their bottom line.

As for GE Healthcare, we assume key market drivers include increased access for healthcare services from emerging economies and an aging U.S. population, coupled with digital initiatives that save practitioners’ time, while protecting them from risks. Rolling this up, we believe these factors will help drive lower mid-single-digit sales growth, coupled with a minimum 25 basis point improvement in year-over-year margins. For Power and Renewables, we see both segments benefiting from the energy transition, but with the lion’s share of the sales growth opportunity flowing through to renewables. That said, we expect minimal contributions to profitability over the next couple of years from either business, before ramping up to mid-single-digit plus margins by midcycle.

General Electric’s Company Profile

GE was formed through the combination of two companies in 1892, including one with historical ties to American inventor Thomas Edison. Today, GE is a global leader in air travel, precision health, and in the energy transition. The company is known for its differentiated technology and its massive industrial installed base of equipment sprawled throughout the world. That installed base most notably includes aerospace engines, gas and steam turbines, onshore and offshore wind turbines, as well as medical diagnostic and mobile equipment. GE earns most of its profits on the service revenue of that equipment, which is generally higher-margin. The company is led by former Danaher alum Larry Culp who is leading a multi-year turnaround of the storied conglomerate based on Lean principles.

Source: Morningstar

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Funds Funds

MFS Intl Diversification R6

As expected, this fund of funds added MFS International Large Cap Value MKVHX as the sixth fund on its roster in 2020 after holding the same five funds during for its first 16 years. MFS International Large Cap Value uses a value process, while the five original funds (MFS Research International MRSKX, MFS International Intrinsic Value MINJX, MFS International Growth MGRDX, MFS International New Discovery MIDLX, and MFS Emerging Markets Equity MEMJX) use blend or growth disciplines. The 2020 expansion makes this already diversified fund even more so.

The processes of the six underlying funds are sound and complementary, and provide this fund with an edge. Steven Gorham and David Shindler of MFS International Large Cap Value look for strong fundamentals and attractive valuations as Gorham previously did with other managers at MFS Value MEIKX. The team at MFS International Intrinsic Value seeks sustainable competitive edges and other strengths. The teams at MFS International Growth, MFS International New Discovery, and MFS Emerging Markets–which previously or currently have comanagers in common–all use the same valuation-conscious quality growth discipline. The team at MFS Research International seeks fundamental strengths and reasonable valuations. And though MFS International Large Cap Value doesn’t have an Analyst Rating and thus no Process Pillar rating, MFS Value MEIKX has a Process score of High, while four of the five of this fund’s five long-time funds have Process ratings of Above Average.

Gorham and Shindler are seasoned and skilled. Gorham has a solid record as comanager on a value-oriented global fund as well as strong record a comanager at MFS Value, and Shindler has succeeded as a comanager on a U.K. large-cap strategy. The teams of the other five funds are also strong.

The Fund’s Approach

MFS International Large Cap Value MKVHX was added as the sixth strategy on this fund of funds’ roster as expected in mid-2020, and its weight was raised to its target allocation of 15% during the second half of the year. The weights in MFS International Intrinsic Value MINJX and MFS International Growth MGRDX were lowered to 15% each from 22.5% each. The weight to MFS International New Discovery MIDLX remained at 10%. The weight in MFS Research International MRSKX was lowered to 27.5% from 30.0% during the second half of 2020, while the allocation to MFS Emerging Markets Equity MEMJX was increased to 17.5% from 15%. Steven Gorham and David Shindler of MFS International Large Cap Value look for strong fundamentals as well as attractive valuations (as Gorham previously did successfully with other comanagers at MFS Value MEIKX). The team at MFS International Intrinsic Value seeks sustainable competitive edges and other strengths.

The teams at MFS International Growth, MFS International New Discovery, and MFS Emerging Markets all use the same valuation-conscious quality growth discipline. And the team at MFS Research International looks for fundamental strengths and reasonable valuations. Adding a sixth fund made sense for diversification reasons. The six underlying processes are sound, complementary, and proven, supporting an Above Average Process rating.

The Fund’s Portfolio

This fund of funds added a foreign large-value fund to its roster in mid-2020 to complement the one foreign large-blend offering, two foreign large-growth funds, one foreign small/mid- growth offering, and one diversified emerging market fund it has owned since its 2004 inception. With this addition to its roster, its already quite wide-ranging portfolio has become even more so. It owned 597 stocks and devoted 16% of its assets to its top 10 as of April 2021 versus 536 and 18% as of May 2020. (The typical actively run foreign large-blend fund owns around 80 stocks and devotes roughly 25% of its assets to its top 10.) This fund is also even more diversified by style, sector, and country now. But all six of the underlying funds use distinctive strategies and allow their stock selection to lead to moderate sector and country overweighting’s, so this funds portfolio isn’t so broad that it’s completely bland. Indeed, several of the underlying funds have found a significant number of attractive investments in the consumer defensive sector, so this fund has a 14.1% stake there versus 9.5% for its average peer and 8.6% for the MSCI All Country World Index ex USA category benchmark. It also has a fairly modest stake in the consumer cyclicals sector. This fund has an average market cap of $38.7 billion versus $54.4 billion for its average peer and $46.9 billion for the index.

The Fund’s Performance

This fund of funds has lagged as most international stocks have gyrated their way to big gains over the past 12 months. Its Institutional share class gained 39.6% during the year ending April 20, 2021, whereas the average member of the foreign large-blend Morningstar Category returned 43.7% and the MSCI ACWI ex USA category benchmark gained 43.0%. This fund of funds was slowed by the fact that the two foreign large-growth offerings and one foreign small/mid-growth fund on its roster couldn’t keep up with their bolder rivals. Finally, this fund has also posted superior risk-adjusted returns during the trailing three-, five-, 10-, and 15-year periods. Over the longest period, the Institutional share class has earned a Morningstar Risk-Adjusted Return of 2.3% versus Risk Adjusted Returns of negative 0.2% for both its average peer and the index.

Source: Morningstar

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Technology Stocks

Strength in Notebook Demand Continues to Drive HP as Print Picks Up; Maintaining $23 FVE

Stock market graph with screen

We believe personal computer purchases will contract as more households primarily use smartphones for computing tasks and as cloud-based software upgrades can delay the impetus to upgrade computer hardware. HP’s personal systems business, containing notebooks, desktops, and workstations, yields a narrow operating margin that we do not foresee expanding. The company’s growth focus areas of device-as-a-service, or DaaS, and expanding its gaming and premium product offerings should help stem losses from its core expertise of selling basic computer systems. Contractual service offerings like HP’s DaaS are alluring to businesses since IT teams can offload hardware management, receive analytics to proactively mitigate computer issues, and pay monthly instead of facing unpredictable large capital expenditures.

HP’s contractual managed print services, in additional to focusing on graphics, A3, and 3D printers are moves in the correct direction, but the overarching trend of lower printing demand should stymie revenue growth within printing, in our view. HP is combatting the challenge of lower-cost generic ink and toner alternatives in the marketplace. The company is innovating in a mature market, but we believe competitors can mimic HP’s successes or cause price disruption. HP’s scale may enable success within the 3D printing market; even though HP is late entrant, its movement into printing metals could cause customer adoption. Our largest concern with the printing market is the overall trend of screen reading replacing printed pages, and we do not believe HP’s initiatives can offset the macro trend.

Fair Value and Profit Enhancers

Our fair value estimate for HP to $23 per share. This fair value estimate represents a fiscal 2021 enterprise value/adjusted EBITDA of 5 times and a free cash flow yield of 15%.

ur model assumes that HP’s market segments of personal systems and printing decline over the longer term. Smartphones can be used for most PC tasks and we believe that the computer hardware refresh cycle could grow beyond the historical average of three to four years as cloud-based software updates extend the life of existing hardware.

The printing market, in general, is being hampered by the trend of printing less items for economic and environmental purposes. We surmise that HP may garner some printing growth from its movement into the A3, graphics, and 3D printing markets; however, declines in HP’s historical core printing segments may offset any potential gains. Through fiscal 2025, we expect HP’s gross margins to remain in the high teens while its operating margins oscillate around the mid-single digits.

HP’s Company Profile

HP Inc. is a leading provider of computers, printers, and printer supplies. The company’s three operating business segments are its personal systems, containing notebooks, desktops, and workstations; and its printing segment which contains supplies, consumer hardware, and commercial hardware; and corporate investments. In 2015, Hewlett-Packard was separated into HP Inc. and Hewlett Packard Enterprise and the Palo Alto, California-based company sells on a global scale.

Source: Morningstar

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

Lowering Harmonic Drive’s FVE but Still See Upside Potential; Wide Moat Remains Intact

We note that our revised expectation of margin expansion is still higher than management’s plan and we currently see upside potential in the low- to mid-teens percent. Throughout calendar 2020, the company’s share price grew significantly as a result of high growth expectations for HDS’ strain wave reduction gears, which serve as vital components for high precision machinery like industrial robots and semiconductor equipment. However, since reaching its peak of around JPY 9,200 at the end of 2020, HDS’ share price has fallen year to date, as the market’s excessively high growth expectations have been corrected.

The medium-term plan, ending in fiscal 2023, implies that operating margin will return to normalized levels in fiscal 2023–at 21.4%, from 2.3% in 2020. We believe the plan is conservative, but we also take this into account for our downward revision to our projection. Further, we consider the potential impact of pricing, as management commented that a domestic industrial robot manufacturer (HDS’ customer) hopes to eventually adopt a “two company” supplier policy for small-size reduction gears. At the moment, compared with other manufacturers’ gears, there is a significant pricing premium on HDS’ strain wave reduction gears due to hurdles by other companies in replicating the quality of HDS’ high-end gears. We note that this impact would not be immediate and that despite the likelihood of reduced pricing over the medium/long term, HDS’ wide moat remains intact, as the high-end strain wave gear market is not a “winner take all” market and will likely continue to have high barriers to entry.

Over the medium term, we assume margins will increase from 22% to 25.5% between fiscal 2022 and 2025, compared to 25% to 28% in our previous projection during the same year. Further, we maintain our fiscal 2021 operating margin of 18%, which is also higher than management guidance of 12.7% margin for the same year. We think this is possible, based on higher sales assumptions compared to guidance and after considering its high contribution margin of about 50%. We note that our assumption still implies operating margin of 5 percentage points lower compared to fiscal 2017 levels despite similar companywide revenue levels. We attribute this margin gap between 2017 and our 2021 projection to: 1) higher production-related costs, including increased expenses related to the operations of its new factories in Japan and North America as well as record D&A levels as a result of peak capital investments in 2018 and 2019; 2) increased R&D spending as part of its medium-term plan; and 3) near term rise in costs related to packaging and shipping.

For the current fiscal year, we assume 47% top-line year-on-year growth, which is higher than both guidance and our previous projection (40% and 37% year-on-year growth, respectively), as we expect stronger top-line recovery in Japan/Asia and Europe segments. We attribute this to order improvement in the fourth quarter, which exceeded our previous expectations, and likelihood of further increases in orders/sales throughout the fiscal year from industrial robot and collaborative robot, or cobot, manufacturers in these regions, as factory automation investments in the automobile industry pick up. Fourth-quarter consolidated orders in the Japan/Asia segment more than doubled year on year, and order growth in the Europe segment also turned positive in the fourth quarter with 12% year-on-year growth, after two consecutive declines from same periods of the previous year. We expect these factors will also contribute to margin expansion going forward.

The company’s fiscal 2020 year-end results, ending in March, were in line with our expectations, as companywide revenue remained flat year on year, while operating margin remained low at 2.3%–though this is an improvement from minus 0.5% in 2019. Margins have been impacted by high fixed costs from its newly constructed factories in Japan and North America, where HDS spent in excess of JPY 30 billion or 30% of sales collectively in 2018 and 2019. While the parent entity’s standalone operating margin improved by about 8 percentage points to 10.6%, from strong sales to Japanese industrial robot makers, other key group companies in North America and Europe realized declining operating income from lower sales for mainly non-industrial robot applications (such as for medical, amusement, and service robot industries).

Harmonic Drive Systems Inc Company Profile

Harmonic Drive Systems Inc., or HDS, manufactures and sells precision control equipment and components worldwide. It offers high-precision reduction gears (speed reducers) under the Harmonic Drive brand as well as other mechatronics products such as rotary actuators, linear actuators, and AC servo motors. The company also provides planetary-gear speed reducers under the Accu Drive and Harmonic Planetary brands. Its products are used in industrial robots, semiconductor manufacturing equipment, and other high precision equipment. HDS was founded in 1970 and is headquartered in Tokyo, Japan.

Source: Morningstar

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Funds Funds

Jackson Square Large-Cap Growth Inv

Longtime manager Daniel Prislin has also announced that he will retire at the end of 2021. Jeff Van Harte and comanager Prislin have comanaged this fund since April 2005, with Chris Ericksen following shortly thereafter. Billy Montana became a comanager in January 2019, having joined the firm in 2014. The team looks for growth of intrinsic value rather than rapid earnings growth

Sensible approach, but stock-picking has been subpar

The team here has applied the same repeatable approach since taking the helm, but it has not translated into consistently strong stock-picking. Some recent tweaks are encouraging, but it’s too soon to tell how enduring these positive results will be. This team of generalists searches for companies undergoing or likely to undergo a fundamental change that will lead to higher growth and a robust business model that generates ample free cash flow. The team is happy to have companies with high earnings, but it must lead to growth in intrinsic value.

The team tries to avoid high-growth companies that are not great businesses or are simply riding a cyclical wave. It looks for firms that can grow their value in a variety of economic environments. It also prefers companies with low capital intensity, which tends to lead to below-average debt/capital ratios in the portfolio.

The approach culminates in a concentrated portfolio of roughly 30 stocks. The team still has an investment horizon longer than most but has made recent tweaks to ensure that it isn’t holding on to names experiencing fundamental deterioration. Recent results are encouraging, but the team still needs to demonstrate it can maintain an enduring edge

A compact portfolio

The team builds a relatively concentrated portfolio of approximately 30 stocks, but it consistently looks worse than the Russell 1000 Growth Index on quality measures such as average returns on invested capital, assets, and equity. Its average debt/capital ratio sometimes looks better, though. While the team takes valuation into account, the portfolio looks mixed on valuation measures. Its average price/book ratio is lower than the benchmark’s, but the portfolio looks more expensive on price/earnings, price/free cash flow, and price/sales ratios. Sector and industry bets are byproducts of the team’s bottom-up stock selection. In March 2021, the team held no consumer staples stocks relative to the bogy’s 4.3% and allocated 49% to tech stocks versus the bogy’s 44%.

The portfolio’s concentration has not contributed to higher active share recently (a measure of a portfolio’s differentiation from its benchmark). Active share was just 70% at the end of 2020, down from 85% in 2016. Large portfolio holdings like Microsoft MSFT and Amazon.com AMZN are also large benchmark constituents, contributing to the lower active share. Indeed, 20 of the portfolio’s 28 holdings were initiated in 2020 or later.

Challenged performance

Stock-picking has been subpar o n this team’s watch. From the April 2005 start of longest-tenured comanagers Jeff Van Harte and Daniel Prislin, theInvestor shares’ 11.3% annualized return through April 2021 trailed its typical large-growth peer and Russell 1000 Growth Index benchmark by 0.5 and 1.6 percentage points, respectively. A couple of bad years weigh on recent results. The fund landed in the bottom of its peer group in 2016. Poor stock picks in the healthcare and consumer cyclical sectors, including names like Valeant Pharmaceuticals VRX and TripAdvisor TRIP, hurt the most.

More recently, the fund struggled in 2019, landing in the worst-performing quintile of the large-growth category. TripAdvisor was again a large detractor. The team has made some tweaks, acknowledging a tendency to hold on to names too long, but it’s too soon to tell how fruitful these adjustments will be. The fund is off to a strong start with this modified approach, though. In 2020, its top-decile 44.1% beat the bogy’s 38.5% return. Losing less than the bogy in 2020’s first-quarter drawdown helped it to that strong calendar-year showing, with new investment ideas contributing the most to outperformance. Indeed, the team bought eight of the 11 top contributing names in 2020 over the prior 18 months.

(Source: Morning star)

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